BankruptcyDixon Gardner

PG&E Bankruptcy Update: It’s All About Funding a Plan

On January 29, 2019, PG&E Corporation (“PG&E”) filed its petition for bankruptcy relief in the United States Bankruptcy Court for the Northern District of California.  As will be discussed in detail below, PG&E’s petition came in the wake of wildfire-related lawsuits that exposed PG&E to billions of dollars in potential liabilities.  As of September 30, 2019, PG&E has been in bankruptcy for 8 months and its bankruptcy case is unresolved.  This article provides an update on the status of this significant bankruptcy case.

PG&E’s Reorganization Goals

At the annual shareholder meeting on June 21, 2019, PG&E’s shareholders elected 12 new directors to the board of directors to serve 1-year terms, who appointed a new CEO.  Only two of the prior directors remain.

Shortly thereafter, PG&E’s CEO stated that PG&E’s “primary focus areas are to further reduce the risk of wildfires in the communities we serve, to improve our safety and operational performance across the board, and to move expeditiously through the Chapter 11 process.”

These areas require PG&E to invest in its electrical system by removing vegetation (mainly trees) and repairing the equipment; improve the safety measures taken in operating and upgrading the equipment; and prepare a comprehensive reorganization plan.

This reorganization plan has to resolve the following issues to be approved by PG&E’s creditors, shareholders, and the Bankruptcy Court: (1) resolve claims arising out of the 2015 Butte Fire in Amador County, 2017 Tubbs Fire in Sonoma County, and 2018 Camp Fire in Butte County (collectively referred to hereafter as “Wildfire” or the “Wildfires”) by determining a final claim amount or establishing a process to determine such amount; (2) fund investments geared towards improving electrical system safety and maintenance; (3) sell enough bonds, stocks, and rights to pay Wildfire claimants and PG&E’s creditors.

Resolving Wildfire Claims

In June 2019, PG&E announced that it had entered into $1 billion in settlements with more than a dozen cities, counties, and other jurisdictions for damages attributed to PG&E’s faulty equipment.

In mid-August 2019, the Bankruptcy Court lifted the automatic stay on lawsuits tied to the 2017 Tubbs Fire and allowed claimants to pursue their claims against PG&E.  PG&E has filed an appeal of this ruling to prevent these lawsuits from going forward outside of bankruptcy court.  Attorneys for the fire victims dispute the State’s finding that a private electrical system caused the Tubbs Fire—rather than PG&E—and hope to recover on behalf of the individuals affected by the Tubbs Fire.    Even so, it will take at least 18 months to finalize claim amounts and obtain judgments for these lawsuits.  The lawsuits involve general unsecured claims, meaning that they will most likely be litigated before the Bankruptcy Court and PG&E will be required to pay such award no matter the outcome of the bankruptcy case.  In other words, these claims are “non-dischargeable claims” because PG&E’s reorganization plan cannot discharge its liability for these claims once it has been decided that PG&E intentionally caused the claimants’ injuries by permitting its electrical system to fall into disrepair, thereby causing the Tubb Fire.

On September 13, 2019, PG&E announced that it had reached an agreement in principle to pay $11 billion to resolve most of the insurance company claimants’ claims arising from the Wildfires.  While the insurance companies involved in the September 13, 2019 settlement represent roughly 85% of the claims against PG&E, there remains a large group of claimants whose cases remain pending in state and federal courts.

Looking back, as of June 30, 2019, PG&E had only recorded $3.9 billion of Wildfire claim liabilities in its financial statements.  While the final amount of total Wildfire claims is uncertain, insurance companies estimate that the total amount of the Wildfire claims totals around $18 billion.  PG&E has issued statements that the Wildfire claims range from $10 billion to $30 billion and Wildfire victims claim that their claims are worth $40 billion.  Notably, part of PG&E’s reasoning for filing for bankruptcy protection in January 2019 was it did not believe it could afford to pay an estimated $30 billion in damages.  However, PG&E used $18 billion as the total claim amount in its initial reorganization plan filed on September 9, 2019.  Considering these discrepancies and looking at the amounts PG&E has already paid, it appears that $18 billion is insufficient to pay the claims against PG&E.

Recently, PG&E filed its reorganization plan to start negotiations with creditors, Wildfire claimants, and stockholders in order to recover financially.  The reorganization process takes time and will be litigated in the bankruptcy court. The main issue will be whether the Bankruptcy Judge will permit the Wildfire claimants to be paid less than their full claim amounts while permitting PG&E stockholders to retain their stock holdings.  Under the Absolute Priority Rule (known as Title 11 United States Code Section 1129(b)), a creditor with a right to priority to payment under a reorganization plan has the right to be paid in full for his claim before both claimants with lower priority and stockholders are allowed to keep their claim or interest in the debtor to be reorganized.  In PG&E’s bankruptcy case, the Wildfire claimants have the right to be paid in full for all their claims before any preferred stockholder and any common stockholder of PG&E have a right to keep their stock interest in PG&E.  Despite this statute, bankruptcy courts have developed an exception to it called the “New Value Exception.”  This exception requires that stockholders invest more money into the debtor corporation to maintain their interest in the corporation even though the creditors above them are not paid in full as required by the Absolute Priority Rule.  Finally, there are bankruptcy courts that find the Absolute Priority Rule does not apply to a reorganization plan to keep shareholders involved as long as creditors do not object.

Regardless of the Bankruptcy Judge’s decision about the Absolute Priority Rule, the losing side will likely appeal the decision until all appeals are exhausted because of the billions of dollars at stake in this decision.  Such appeals will only lengthen the process and delay payment of the Wildfire claims.

This summer, the California legislature approved a $21 billion wildfire fund, which is to be funded by annual contributions from California utility companies, such as PG&E.  This fund will act as insurance to pay the liabilities of power utility companies whose equipment causes a wildfire in the future.  In sum, California believes that wildfires are a recurring risk for utility companies and that companies must be proactive in protecting themselves from fire liability-induced bankruptcy.

PG&E’s Investment to Improve Electrical System Safety and Maintenance to Avoid Wildfires

PG&E needs to consistently commit its cash flow and invest in improving its electrical system safety and maintenance to avoid wildfires.  This was not done by prior management.

In August of 2019 the Wall Street Journal reported that PG&E conducted an unusual inspection of the power line that sparked the 2018 Camp Fire just weeks before the line failed.  The disclosure that workers climbed portions of the Caribou-Palermo line (near the origin of the Camp Fire) in the fall of 2018 suggests PG&E had concerns about the condition of its electrical transmission lines prior to the wildfire that killed 86 people and destroyed the town of Paradise.  Before the Camp Fire, which prompted PG&E to conduct more extensive reviews of its power grid, it was unusual for PG&E to climb its transmission towers to inspect their condition and that of the bolts, hooks, and other hardware in these towers and transmission lines.  However, nothing was done to prevent the hazards that later caused the Camp Fire.

As of September 2019, PG&E has nearly completed inspections of its electric infrastructure in high fire-threat areas (i.e. forests and grasslands).  This work has included thorough inspections of approximately 50,000 electric transmission structures, 700,000 distribution poles, and 222 substations covering more than 5,500 miles of transmission line and 25,200 miles of distribution line.  Through these efforts, PG&E has discovered nearly 1,000 immediate safety risks and 10,000 lower-priority problems throughout its electrical system and has repaired or is actively working to repair such problems.  The problems include damaged transmission towers, broken hardware on local distribution poles, and leaking transformers in its substations.  PG&E also continues to address safety risks as they are identified during these inspections.  These efforts indicate that PG&E has accepted that its equipment is dangerous and is stepping up to prevent its equipment from sparking future wildfires.  That said, PG&E is working through more than 3,700 repairs as California’s wildfire season (from approximately August until November) continues.

It is clear that this type of inspection should be conducted on a regular basis to significantly reduce or eliminate the inherent risks that PG&E’s electrical system poses to fire-susceptible areas.  This can only be done if PG&E commits to investing in improving its electrical system safety and maintenance, and it appears that PG&E is taking steps to do this.

Proposals and Funding Sources for a Confirmable Reorganization Plan

PG&E has stated that it is committed to settling fire claims, honoring all power purchase agreements, and paying all claims in full without raising electricity rates when recovering from bankruptcy by June of 2020.  However, PG&E’s ability to fund a reorganization plan depends on PG&E’s ability to fund the Wildfire claims since these claims are PG&E’s largest liability in such a plan.  Without a final Wildfire claim amount, the level of funding needed by PG&E for its plan is uncertain.  It will take years to finalize these Wildfire claims, especially since the Bankruptcy Judge permitted the Tubb Fire claimants to sue PG&E in California courts.  This could take years for PG&E to develop an accurate reorganization plan.

The Bankruptcy Judge extended PG&E’s exclusive right to file a Chapter 11 plan until it exits bankruptcy in order to avoid delays caused by competing plan proponents and shorten the timeline for its plan to be confirmed.  This ruling will help PG&E confirm a plan faster (and pay the Wildfire victims faster) than if hedge funds were to use their large stock and bond positions to propose a plan favoring their investment.  One hedge fund (Elliot Management Corp.) has already proposed a huge debt issuance to fund a plan, but at the expense of PG&E’s shareholders.  Such a plan may be the only option for a confirmable plan if the Absolute Priority Rule is enforced, but it would eliminate all claims and interest in PG&E that have a lower priority than the Wildfire claimants.  Under such a plan, the interests of all of PG&E’s current stockholders would be eliminated and PG&E’s stock would be issued to the Wildfire claimants to satisfy PG&E’s liabilities to them.

There are other efforts to fund the plan through the sale of assets or through tax-exempt bonds.  As of June 30, 2019, PG&E had over $83 billion in assets to pay $72 billion in debts.  The City of San Francisco, Yolo County, and the South San Joaquin Irrigation District have offered to buy the power lines and the electrical systems that serve their areas from PG&E.  The California Public Utility Commission (“CPUC”) is also exploring ways to make PG&E’s operations safer by splitting PG&E’s gas and electric divisions into separate companies and selling PG&E’s electric grid to cities.  The California Assembly has debated whether to sell tax-exempt bonds at low interest rates to pay Wildfire claims now and have PG&E pay off the bonds later from its future profits.  PG&E agrees this bond issuance is the fairest way to pay Wildfire victims.

Another way for PG&E to reorganize would be to sell itself to another utility company.  However, in August of 2019, Warren Buffett, the CEO of Berkshire Hathaway (an owner of electric utility companies), denied that his company was interested in buying PG&E.  No utility company has made a serious offer to buy PG&E.

PG&E has a goal of raising $14 billion from the sale of common and preferred stock and bonds in its reorganization plan to fund these claims and other Wildfire liabilities.  By August 2019, PG&E had obtained $12 billion in equity finance commitments.  Two large hedge funds have proposed to raise $15 billion from the sale of rights to buy new common stock from PG&E to fund its plan and PG&E has obtained a loan in bankruptcy of $1.5 billion to fund its operations. With $72 billion in debts to service, PG&E may have to pursue all of the foregoing options since its first six months of revenue in 2019 was only $7.954 billion (about $16 billion annually) and its cash flow from operations was only $2.75 billion (about $4.5 billion annually).  Of this $2.75 billion, PG&E invested $2.43 billion into its safety and maintenance program.   As of June 30, 2019, PG&E had only generated $1.74 billion (about $3.5 billion annually) in cash from its operations and had just over $3 billion in cash to pay bankruptcy claims of over $41 billion.  Despite PG&E’s pledge not to raise electricity rates to fund its plan, its financials indicate PG&E will have to raise such rates.  Another source of funding may be the State of California, which may find it is in its best interest to fund PG&E’s reorganization plan to ensure he lights stay on in Sacramento and the rest of Northern California.

Dixon Gardner

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